Constructing a Model Portfolio

Includes: LSC
by: Roger Nusbaum

A portfolio manager/blogger named Carlton Chin had an interesting post at Seeking Alpha titled A Well Balanced Portfolio Including Alternative ETF Allocation which might be fun to dissect. This has a sort of Permanent Portfolio feel to it, but I may be wrong about that.

Chin's allocation as follows:

15% US stocks
15% Foreign developed stocks
10% Emerging markets
15% Bonds
10% REITs
15% Foreign REITs
20% Commodities

Chin goes on to suggest various ETFs, mostly from Vanguard, for each of the segments. Oddly, for commodities he suggests the Elements S&P CTI (NYSEARCA:LSC), which I would say is more of a proxy for absolute return as opposed to being either a broad or narrow proxy for commodities. If he meant 20% in actual commodities, that is a lot more than I would feel comfortable with. Commodities are generally added to this type of portfolio for diversification benefits, but they are very volatile at times. At some point (before getting to 20%) that volatility can start to work against an investor who is not looking to actively trade the portfolio. If Chin were to say the volatility is mitigated by choosing LSC, I would say that LSC uses commodities to achieve a different type of result.

The exposure to REITs is way more than I would ever consider. The yield comes in handy most of the time, of course, but the correlation exhibited by the group to the US broad market and US financial sector leaves me thinking that even an aggressive weighting would be well under the 25% Chin suggests.

For equities, the only examples given are the broadest of ETFs. There is nothing that says that portfolios like these can only use broad funds. Chin's concept could certainly appeal to someone with investable assets of $700-800k, which would mean $280-320k in equities. In my opinion, this dollar range should own more than five broad ETFs, but I realize not everyone would agree with me on that.

The section on bonds only mentions a couple of domestic treasury ETFs and a total bond market fund. I would urge far more diversification than this, especially some sort of foreign exposure. The ETF market for fixed income has improved dramatically, offering access to quite a few segments that were previously very difficult to access.

Exploring these types of alternative portfolio structures is a worthwhile pursuit -- not in terms of turning your own portfolio inside out based on what might be a persuasive article, but more along the lines of taking little bits of others' processes to make your own. Some folks are well ahead of where they need to be, and so really reducing volatility -- versus something like a 65% allocation to equities, which seems to be a common number -- becomes something that should be considered. Chin's portfolio kind of addresses this idea, although I would disagree with him on REITs and commodities.

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